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Years of low rates of interest have made the present financial disaster worse, says Rosengren of the Fed

Eric S. Rosengren, President and CEO of the Federal Reserve Bank of Boston

Keith Bedford | Reuters

Years of low interest rates created undue risk in commercial real estate and will exacerbate the current economic downturn, said Eric Rosengren, president of the Boston Federal Reserve, Thursday.

The central bank official said he expected a wave of defaults and bankruptcies that would exacerbate an unemployment problem that has disproportionately hit low-wage workers.

Regulators should have been able to create conditions that would make an unexpected crisis worse.

"Obviously a deadly pandemic had a huge impact on the economy," said Rosengren. "However, I am sorry to say that the slow increase in risk in the low interest rate environment that preceded the current recession is likely to complicate economic recovery from the pandemic."

The Fed has been at the center of the crisis response to the coronavirus by cutting already low interest rates and implementing a range of programs to keep the market working and lending money to sectors in need.

In the last few days it has adjusted an even more cautious approach to monetary policy, pledging not to hike rates even if inflation is above the Fed's preferred 2% target.

A loose Fed is also often the target in times of plenty, such as the financial crisis and the dot-com bubble. Rosengren's remarks reflected concerns about the consequences of the low rates that have prevailed over the past twelve years.

He noted that commercial real estate companies "have gradually increased risk by taking on more leverage, which increases returns with good results – but also increases losses when poor results occur."

"This increase in risk appetite is more likely to take place in a low interest rate environment, as prevailed after (and as a result of) the financial crisis and the great recession."

He specifically stated that "low interest rates will persist for extended periods of time even after the economy has advanced," as was the case when the Fed kept its short-term policy rate near zero for more than six years after the Great Recession ended in 2009.

During these times, "businesses and firms are taking on additional debt and accumulating riskier assets in search of better returns – potentially causing asset prices to rise to unsustainable levels," he said.

The consequences of this climate will soon be felt with the threat of debt defaults and business failures. The impact on banks, especially smaller institutions, is likely the reason for the underperformance of the sector's equity markets.

He also spoke about the impact on employment, particularly those in the service industry, who have been hardest hit during the current downturn.

"The rise in commercial real estate risks and leverage in the corporate sector prior to the COVID-19 pandemic are likely to result in more bankruptcies and higher unemployment in this crisis than if fewer risks had been taken," he said.

While banks currently have strong capital positions, lending standards are strict. Rosengren said that placing the financial system at the center of several economic crises should prompt officials to consider the impact of "earning opportunities".

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